KESONIA : What determines your loan cost?

Kenya’s banking sector has entered a new era with the introduction of the KESONIA (Kenya Shilling Overnight Interbank Average) as the common base rate for all variable-interest loans.

This reform, rolled out under the guidance of the Central Bank of Kenya (CBK) and the Kenya Bankers Association (KBA), is designed to create a loan pricing framework that is transparent, predictable and fair to borrowers.

What is KESONIA?

KESONIA stands for the Kenya Shilling Overnight Interbank Average. It is the average interest rate at which banks lend money to each other overnight.

• Banks often run short of cash at the end of a business day.
• To cover these shortfalls, they borrow from each other, usually for just one night.
• The rate at which they lend to one another changes daily depending on market conditions.
• KESONIA is the average of all these overnight lending rates across the banking system.

This makes KESONIA:

Market-determined – It reflects real activity in the financial system, not just policy decisions.
Transparent – Published daily, meaning borrowers and lenders can see the base rate in real time.
Dynamic – Adjusts automatically to reflect shifts in liquidity, inflation and monetary policy.

Why replace the old system?

Previously, banks used different internal formulas for calculating their base lending rates. This made it difficult for customers to compare loan offers across banks. Some borrowers suspected hidden costs or unfair pricing.

The CBK and KBA introduced KESONIA to:

• Standardize loan pricing across the industry.
• Reward financial discipline by linking credit history to interest rates.
• Improve transparency, so borrowers can predict how their rates might move.
• Align Kenya with global banking standards, where interbank rates are used as benchmarks.

The Loan Pricing Formula

Under the new framework, the interest rate on your loan will be calculated using this formula:

Loan Interest Rate = KESONIA + Risk Premium

1. KESONIA: This is the common base rate. It changes daily but is published publicly, so you know what banks are using as the starting point.
2. Risk Premium: This is an extra margin added by your bank based on your creditworthiness.
   • If you have a good repayment history (you pay loans on time and have not defaulted), your risk premium will be low.
   • If you have a poor repayment record (missed payments, defaults, or heavy borrowing), your risk premium will be higher.

For example:

• If KESONIA today is 10% and your bank adds a 2% risk premium, your loan interest rate will be 12%.
• Another borrower with a weaker repayment history may face a 5% risk premium, giving them a loan rate of 15%.

How is KESONIA Calculated?

The process is systematic:

1. Every day, banks report the rates at which they lent and borrowed money overnight.
2. The CBK compiles these figures and calculates the average rate across the system.
3. That average becomes the KESONIA rate for the next day.

This ensures that the base rate is based on real, market-driven activity, not arbitrary decisions.

What This Means for Borrowers

For ordinary Kenyans, the KESONIA system introduces several important changes:

1. Fairness – Everyone starts with the same base rate (KESONIA). What changes is your risk profile.
2. Transparency – You can check KESONIA daily, just like forex or stock prices and understand how your loan interest rate is built.
3. Incentives for Good Behavior – Paying your loans on time and maintaining a healthy credit score now directly lowers your borrowing costs.
4. Variable Nature – Since KESONIA changes daily, your loan interest rate may also shift if you’re on a variable-interest loan. That means costs can go up or down depending on liquidity and market conditions.

Author: Moureen Koech